Will the True Gold/ Silver Ratio Please Stand Up?

Indeed, “There are only two places where the gold:silver ratio [now] has any significance,” noted Rhona O’Connell (then at T.Hoare & Co, today at StoneX) in January 1997’s Alchemist No. 6, pointing to New York’s Comex futures market and the giant consumer nation of India, “where if the two go out of kilter it is not unusual for holders to sell (relatively expensive) gold in order to buy (relatively cheap) silver.” Transformed by demonetisation into a trading signal, the ratio has repeatedly been named as a prompt for traders, and not only when it peaked. “Historically, silver is still cheap,” reckoned one bank trader to the LA Times in April 1987 after silver made its fastest average monthly gain since 1980, rising 32% from March in dollar terms on a sudden flood of investment buying. That cut the gold/silver ratio from an apparently irresistible 75 to below 55 as rumours spread that top mining nations Mexico and Peru would co-ordinate output cuts to try to boost prices. Four years later, however, the ratio would peak at 100.

April 2011’s level of 35 was, in contrast, “unsustainable”, according to several analysts (including David Jollie, then at Mitsui and now at Anglo American Platinum, whose 2016 article ‘Branding silver’ in Alchemist No. 80 is well worth rereading) – a forecast that soon came good. With silver nearing its record cash price of $50 per ounce, gold showed its cheapest valuation since 1983 in terms of its once monetary sister, dipping to 31 times the silver price before rising to 45 times by the time gold set its own financial crisis peak at $1,920 four months later. The ratio has since averaged 72, marking a sustained derating of silver and culminating (so far) with gold jumping to a spectacular peak in relative value during this spring’s COVID crash, when the looming virus pandemic spurred panic across all finance and commodity markets.

A VERY BRIEF HISTORY OF COIN

The gold/silver ratio exists as a concept today thanks to 2,500 years and more of monetary use. While paper notes began replacing gold in everyday commerce back in the 19th century, and while both metals had been used more as reference points for mental accounting than as hand-to-hand cash for extended stretches of time before then (Western Europe’s ‘bullion famine’ of the 15th century preceded and spurred Columbus’s accidental discovery of the Americas), the very first coins were either gold, silver or copper, wherever they were invented (sometime around the 7th century BCE in each of what is now western Turkey, northern India and north-eastern China).

These three metals, the same metals our grandparents and great-grandparents knew as coins in the early 20th century, differ so much from each other in appearance and scarcity that they clearly carried different levels of purchasing power. So where more than one metal was minted (which was soon pretty much everywhere touched by the idea of coined money) and while copper was used to strike ‘token’ money worth far more than its market value in precious metal terms, a ratio for gold to silver had to be chosen. The choice of a ratio “was inevitable”, says Glyn Davies’ A History of Money. Yet that ratio then immediately “came under pressure”.

NEWTON AT THE MINT

The fact that, in 1720, Sir Isaac Newton could be so philosophical about his South Sea misadventures shows how dramatically his fortunes had changed during the second act of his life. Now aged 78, and despite losing the equivalent of £1.4 million that September at today’s silver prices, he would still die a very wealthy man seven years later. His pall bearers included two dukes, two earls and the Lord Chancellor.

Yet, Newton had been almost penniless when, already the most famous mind in Europe, he reached 50, hit burn-out and, following the death of his mother, suffered a mental breakdown lasting two years. Distressed by the despair and paranoia in his letters, Newton’s friends rallied round – including the philosopher John Locke and senior civil servant (and secret diarist) Samuel Pepys – urging him to quit the monkish gloom of Trinity College, Cambridge and move to London to pick up £1,500 a year as Warden of the Mint.

The job, if you could call it that, would require “not more attendance than you can spare”, according to the man who arranged it, Newton’s former student Charles Montagu, now Chancellor of the Exchequer and a founder of the Bank of England, the South Sea Company’s bitter rival (and the Exchequer’s eager saviour after that bubble collapsed). The six previous Wardens had barely turned up for work, delegating everything to their clerks while collecting a salary worth something today between that of the Prime Minister and a deputy governor at the UK central bank.

Newton certainly enjoyed his new income, taking a four-storey town house in West London’s fashionable St. Martin’s Street as his home. But unlike his predecessors, the mathematician and physicist threw himself into the task, no doubt relishing the work because he also happened to be a keen alchemist.

You wouldn’t know this from Newton’s marble monument in Westminster Abbey (the books supporting his statue’s right elbow are titled ‘Divinity, Chronology, Opticks’, while the Latin inscription calls him ‘Scientist, mathematician, astronomer’) and it doesn’t square with the powdered-wig Member of Parliament, President of the Royal Society and all-round establishment gent he became during his second and vastly more profitable career in the City. But of the 10 million words Newton left in manuscript, according to historian Sarah Dry, roughly three million relate to science and maths, half are on religion and one million words are on alchemy – secret codes, arcane symbols, occult figures, the lot.

“This low price of gold in proportion to silver carries away the silver from all Europe but most especially England,” Newton explained, sucking it into Asia, where silver was more highly valued against the yellow metal. As a remedy, the alchemist’s report led Parliament on 21 December 1717 to ask His Majesty George I to “forbid all persons”from offering or accepting “any of the Pieces of Gold called Guineas” at a rate above 21 shillings “and so proportionately for any greater or lesser piece of coined gold”.

Now, it is true that this slightly lower valuation for gold – effectively a ratio of 15.2 – only slowed and didn’t halt the outflow of silver.
But note the capital letters on ‘Gold’ and ‘Guinea’ in the House of Commons’ address, emphasised in the way that ‘Silver’ and ‘Shillings’ had been in previous orders. Note also that where earlier edicts said no one was “obliged” to accept the guinea above a certain price in silver, now it was forbidden. “Gold was henceforth tied to the money of account,” as historian C.R. Fay, responding to The Times’ Silver Number via the Cambridge Historical Journal, wrote in 1935, “and at once became the de facto standard.”

Newton’s infamous ‘error’ of 1717 didn’t, therefore, put England and the world on gold “inadvertently” over the following century, or not as the common history believes. The shift was immediate and deliberate, if not fully understood at the time.

USELESSNESS HITS A NEW RECORD

Fast forward to late 2020 and, despite recent attempts by some Bitcoin and other crypto asset promoters to revive the metal’s monetary use, neither gold nor silver have functioned as units of account or exchange for almost half a century (not outside the housing market in Vietnam at least, where part payment in gold is common). Where they do retain monetary use, however, is as a store of value. Hard to distinguish from investment in any other assets perhaps, this use is of course led by central banks for gold but is regularly cited for both metals by private bullion buyers and owners.

What then of the gold/silver ratio today? Where gold used to facilitate wholesale and international trade, and silver was for more local and everyday transactions, the yellow metal is now famously useless to industry (less than 10% of annual demand), while silver has become “the indispensable element” (as Washington’s Silver Institute puts it), needed in a vast and growing range of technologies and processes which consistently account for more than 55% of end-user demand each year.

This explains why the gold/silver ratio shot to new all-time highs this spring, driven above its peaks of 1940 and 1991 as the COVID catastrophe almost shutdown global economic activity overnight, suddenly making useless, incorruptible gold supremely useful in a locked-down world. That peak however gave no real insight into our economic or financial future, not beyond predicting to eager traders that silver’s value – both industrial and investment – was very likely to rally.

The pace of the ratio’s dramatic retreat, now back down to the mid-70s, shows that the cultural memory of both gold and silver as money is proving very persistent as quantitative easing and zero-to-negative interest rates, applied to try and revive inflation and growth, force savers to find alternatives to official currency. Anyone considering an investment in one or the other precious metal today should remember that, as historian Andrew Watson said of Western Europe’s medieval coinage compared to that of the Eastern Mediterranean, “To study the monetary history of the one in isolation from the other is like watching a football match from a seat which overlooks only half the field.” But for anyone seeking or believing in a consistently ‘true’ rate for an ounce of gold priced in ounces of silver, it is also worth noting that not even Isaac Newton – almost as devoted an alchemist as he was a passionate decoder of the Bible’s hidden secrets – found anything mystical or eternal in the ratio.